8827 / Can an individual participate in both an HSA and a health FSA?

The IRS has issued guidance providing that taxpayers who participate in health flexible spending accounts (FSAs) that reimburse all qualified medical expenses are ineligible to also contribute to health savings accounts (HSAs) because participation in the FSA constitutes “other coverage” prohibited by the rules applicable to HSAs. This is the case even if the individual only participates in the FSA during the tax year because of a permitted carryover from the prior tax year.

In order to be eligible to contribute to an HSA, a taxpayer must have a high deductible health plan (HDHP), and can also have certain other types of permitted insurance and coverage, as well as preventative care coverage, but not “other coverage.” For these purposes, a taxpayer is not eligible to contribute to an HSA if he or she is covered under a health plan that is not an HDHP that provides coverage for any benefit covered under the HDHP. A health FSA that reimburses for all qualified medical expenses falls within this prohibition.

The ineligibility for HSA contributions continues throughout the entire tax year, even if the carried over amounts are exhausted early in the year.

However, a taxpayer can elect to have unused FSA funds carried over into an HSA-compatible FSA (which is either a limited purpose FSA, a post-deductible FSA or a combination of the two). In this case, a taxpayer will be eligible to contribute to an HSA for the year.¹

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Planning Point: If the client has the choice between an FSA and an HSA, the client should be advised that the two types of accounts have different rules when it comes to distributions. For example, HSAs can reimburse account owners for qualified long-term care expenses on a tax-free basis (FSAs cannot). However, HSAs can only reimburse for health expenses of the account owner’s child if that child qualifies as a dependent. FSAs, on the other hand, can reimburse for those expenses if the child is under the age of 27 as of the end of the tax year (regardless of whether the child qualifies as a dependent). HSAs can also make distributions even if the account owner uses the money for non-medical expenses (although penalty taxes will apply).

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